What it means
A share option gives its holder the right to buy shares at a fixed price, called the exercise price, usually set at the market price on the day the option is granted. If the share price rises later, the holder profits from the difference.
In spring loading, the company or its board times the grant for the days before a favourable announcement, such as strong results or a major contract win. The recipients know, or have reason to believe, that the price is about to rise, so the exercise price is lower than it would be after the announcement.
The opposite practice is called bullet dodging, where awards are delayed until after bad news has pushed the price down. Both involve using information that the ordinary shareholders do not have.
The practice matters because option grants are meant to reward performance that happens after the grant. Spring loaded awards pay out for good news that already exists, which transfers value from shareholders to executives without any effort or risk.
Regulators, investors and governance groups regard the practice with suspicion. Many companies adopt policies that fix grant dates in advance, avoid grants while holding inside information and require board committees to approve awards, and where inside information is misused it may break the law.
Accountants and auditors also watch for it, because unusual patterns, such as a high number of grants shortly before price rises, can signal a weakness in governance. Investors reading the remuneration report can compare grant dates with announcement dates to look for those patterns.
A pattern across several years is far more telling than a single well-timed grant.
In practice
Real-world examples.
Example
A board grants options to senior managers on Monday, and on Wednesday the company announces that it has won a major contract. Shareholders later question why the grant came just before the news.
Example
A governance consultant reviews a company's remuneration report and finds that most option grants came within a week before good announcements. She flags this as a pattern that merits further investigation.
Example
A company adopts a policy that all option grants are made on fixed dates, such as the second Tuesday after results are published. This removes any suggestion that the board picks the timing to benefit executives.
Formula
Calculation
Transferred value = number of options x (price after announcement - exercise price)
A company grants an executive 100,000 options with an exercise price of $20, the market price on the grant date. Two days later it announces strong results and the share price rises to $26. The immediate gain in value is 100,000 x (26 - 20) = 100,000 x 6 = $600,000. Had the grant been made after the announcement, the exercise price would have been $26 and this gain would not exist.Case study
Seen in the real world.
Westbrook Pharma is an illustrative, fictional drug developer whose shares traded at $15. The board approved 200,000 options for the chief executive on a Friday, with an exercise price of $15, three days before announcing positive trial results.
The share price jumped to $21 after the announcement, creating an immediate gain of 200,000 x 6 = $1,200,000 for the chief executive. A large shareholder asked how the board had chosen the grant date and whether it knew the results in advance.
The board could not show a documented reason for the timing. The illustrative lesson is that grants should follow a published calendar, and Westbrook introduced a rule that no award could be made while the company held undisclosed price-sensitive information. It also began to publish its grant calendar at the start of each year, so shareholders could see the dates in advance. Auditors now test a sample of grants each year against the published calendar.
Watch out
Common mistakes.
- Assuming that any option grant before good news is spring loading, when the timing may be coincidence if grants follow a fixed schedule.
- Believing the practice only matters for the executives involved, when it affects all shareholders whose stake is diluted.
- Ignoring the disclosure and tax angles, which can create legal exposure for both the company and the individuals.
Questions
People also ask.
Is spring loading illegal?
It depends on the jurisdiction and the facts, but where it involves misuse of inside information or inadequate disclosure it can break the law or breach directors' duties.
How can a company avoid it?
It can set grant dates in advance, avoid grants while holding undisclosed price-sensitive news and make the remuneration committee responsible for approval and record keeping.
What is bullet dodging?
It is the reverse practice of delaying option grants until after bad news has been released, so that the exercise price is set at a lower level.
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